KUWAIT: Financial markets enjoyed a strong end to 2019 with the US S&P equity index up 3 percent m/m and 10-year treasury yields edging back above 1.9 percent as optimism grew over the outlook for global growth amid mildly encouraging economic data and the agreement of a ‘phase one’ trade deal between the US and China.
Some of this optimism was punctured in January however with the escalation in military tensions between the US and Iran that if sustained could jeopardize conditions in the broader Middle East region. These developments saw the price of Brent crude oil spike to nearly $70/bbl having already finished 2019 on a strong note thanks to the better global demand outlook and fresh OPEC+ supply cuts announced in December.
Trade deal helps lift optimism
Pessimism over the US growth climate has mostly ebbed over the past month amid decent economic data especially on jobs, housing and service sector activity and also the boost to sentiment from the partial US-China trade deal which could ease pressure on the still-weak US manufacturing sector. Estimates of fourth quarter GDP growth have been rising and the Atlanta Fed ‘nowcast’ suggests growth could even have reached an annualized 2.3 percent in 4Q19 from 2.1 percent in Q3.
This would leave growth at a decent 2.4 percent for 2019 overall, though still down from 2.9 percent a year earlier and versus a consensus forecast of 1.6 percent for 2020. A reasonably solid economic picture, a strong stock market, contained inflation and reduced risks from overseas trade point to little urgency from the Federal Reserve to change interest rates from current levels, a view supported by minutes from the bank’s December meeting that showed a growing consensus among officials for keeping policy on hold through 2020.
There was at last some positive news on trade with the US and China agreeing a ‘phase one’ deal that effectively calls a provisional truce on their now 18-month dispute, and is scheduled to go into force from January 15th. The deal sees China purchase $40 billion more US agricultural goods per year, take steps to end forced technology transfer and also avoid currency devaluation to gain competitive advantage. The US on the other hand will halve the 15 percent duties on imports from China introduced in September and shelved further tariff hikes that were scheduled for December.
While the agreement represents a first step in deescalating the quarrel which has dented confidence, trade, and manufacturing worldwide and should ensure no further duty hikes, it leaves tariffs on around $250 billion in US imports from China imposed before September in place and difficult issues such as Chinese state subsidies and cyber intrusions unresolved. Prospects for a substantive ‘phase two’ deal could be influenced by political factors ahead of the November presidential election and to the extent that the deal discourages the Federal Reserve from further policy loosening, the net boost to the US economy could be positive but modest.
In the eurozone, the December composite PMI edged up to 50.9 from 50.6 in November, but points to overall growth remaining at negligible levels. Based upon previous trends, this could be consistent with GDP growth of just 0.1 percent q/q in 4Q19, well below trend and even lower than the 0.2 percent growth recorded in Q2 and Q3. Other sentiment surveys suggest that the worst of the downturn in activity may be over, but any pick-up is likely to be gradual given the still-fragile external climate, signs of a cooling job market and the continued reluctance of the German government to provide significant fiscal stimulus.
The European Central Bank, having cut interest rates to -0.5 percent in September and restarted quantitative easing in November may look to loosen policy a bit further over coming months given that core inflation at 1.3 percent y/y in December remains well below the ECB’s ‘close to but below 2 percent’ target. But the extent could be limited by concerns over the impact on financial stability of negative interest rates, the recent departure of the dovish but influential Mario Draghi as president and as the bank assesses the consequences of ultra-loose policy as part of its broader strategic review of monetary policy this year.